Jump Diffusion Option Valuation in Discrete Time

ABSTRACT

We develop a simple, discrete time model to value options when the underlying process follows a jump diffusion process. Multivariate
jumps are superimposed on the binomial model of Cox, Ross, and Rubinstein (1979) to obtain a model with a limiting jump diffusion
process. This model incorporates the early exercise feature of American options as well as arbitrary jump distributions. It
yields an efficient computational procedure that can be implemented in practice. As an application of the model, we illustrate
some characteristics of the early exercise boundary of American options with certain types of jump distributions.